The Worst of Times – the Not So Worst of Times

Posted on June 26, 2009

The recently released Brookings Institution Metro Monitor confirms something I have thought for some time; the recession’s impact has been very different in the Central U. S., including Memphis, where I live.  Certainly unemployment is up, but there is no feeling of impending doom or of pervasive despair.

Fourteen of the strongest twenty metros in the report are in Texas, New Mexico, Oklahoma, Arkansas, Iowa or Kansas.  Memphis and its neighbor to the south, Jackson, MS, are in the second quintile.  Housing prices in Memphis were flat from Q1 2008 to Q1 2009 and they were actually up in many of the Texas markets.  “What’s going on here?” you might ask.  Certainly the regional focus on agriculture and energy, which remain relatively strong, doesn’t hurt, but I don’t think that’s the primary issue.  The mid-continent never enjoyed the full force of the Bubble to the extent experienced on the coasts, so we just didn’t have as far to fall.

This recession is proving to be a great leveler.  My guess it that this applies not just to states and regions, but to economic strata as well.  All that data which Robert Reich and others use to deplore a growing concentration of wealth at the top, has likely turned dramatically down over the past year as portfolio values have collapsed and outsized bonuses have become the bête noir of the American economy.  For the first time in my thirty-six year career, fear stalks the halls of the major law firms as hundreds, perhaps thousands of six figure associates and more than a few seven figure partners have been laid off by some of the largest and most prestigious law firms in America and similar impacts are being felt throughout the higher end of the economy.

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Commercial Lending – Schizophrenia Reigns Supreme

Posted on June 26, 2009

senior-loan-officers-survey

Many companies remain under pressure from their lenders, but we have seen recent signs that selected lenders are becoming more aggressive in offering new loans to credit-worthy borrowers.  We are quite active in helping companies find senior debt to replace existing lenders and are getting good response from selected lenders, primarily banks that were less impacted by the financial crisis and independent asset based lenders.  In prior years there was little or no need for an investment banker’s assistance in arranging senior facilities, as multiple lenders (both banks and non-banks) aggressively chased all but the worst of credits.  That is no longer the case; today senior deals take a lot of work and persistence, but they can be done.

To summarize the current situation:

•    At the higher end, the loan syndication market remains catatonic with no signs of near term recovery.  This both reflects and creates the almost complete collapse of the Private Equity acquisition market for the larger deals north of $100 million.  Most syndication activity that does occur relates to restructuring of existing credits.

leveraged-loan-maturities
Source: Churchill Financial and Standard and Poors

As the chart above demonstrates, we’ve only seen the tip of the iceberg in leveraged loan maturities.  The peak years for refinancing/renegotiation of the loans created in the buyout boom are 2013-2014, but we are already seeing a strong increase in the number of buyout bankruptcies.  This five year overhang in potentially troubled leveraged loans, means that we are a long way from cleanup of the problems created by excessively liberal lending practices during the buyout bubble.  This indicates that we are unlikely to see another debt fueled boom in the buyout industry before we are well into the 2010’s.  The chart below provides a dramatic demonstration of the extent of the decline in syndicated loan volume, with very little … read the rest

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Allen Stanford Proclaims His Innocence

Posted on April 21, 2009

Recently we have been presented with the spectacle of a high flying banker in deep financial trouble proclaiming that he and his organization have been wrongly singled out for reprisal by the Federal government.  The charges are clear.  His bank aggressively sought deposits from around the world to fund a portfolio of outrageously bad investments, leading to the bank’s insolvency.  The bank funded high paid executives’ lavish lifestyles, including Caribbean junkets, sports sponsorships, a fleet of private jets and outsized bonuses unrelated to actual performance.  Insider loans were made to bail out the personal financial problems of those in control.  Yet that banker has the gall to blame overzealous government actions for his problems.

We are speaking, of course, not of Allen Stanford of Stanford Financial, but of the CEO’s of America’s largest banks.  While there is certainly a difference in degree and Mr. Stanford’s personal style is less than savory, the biggest difference between Stanford Financial and several of our nation’s largest banks, is that the U. S. government chose to bail these institutions out of their mistakes rather than prosecute them as has been done with Stanford Financial.  And these bankers are whining daily about their inability to pay “adequate” compensation due to the restraints placed upon them under the TARP legislation.

Don’t get me wrong, Stanford abused the trust of thousands of investors, many of whom are presumably innocent, and he will likely be punished severely for his apparent wrongdoing.  But so did the big banks.  Had the big banks been allowed to fail in September, as they surely would have absent the federal bailouts, the damage to investors would have been far more dramatic and the retribution on their executives would likely have been far bloodier.  The difference is that they hail from the financial and political centers of the … read the rest

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How Much Risk is the Treasury Really Assuming from the Financial Institutions? (Part 2)

Posted on April 8, 2009

Our previous post raised the question of just how much risk is being assumed by the U. S. Treasury with its apparent implied guaranty of the unsecured obligations of the major financial institutions.  We asked whether the $188 Trillion (notional amount) of derivatives transactions on the books of four major banks (J. P. Morgan Chase, Bank of America, Citibank and Goldman Sachs) could potentially pose risks not fully understood by the banks or their regulators.

In evaluating the potential risks inherent in the derivatives positions of the banks (and more particularly at the risks of the Credit Default Swaps (CDS), it is necessary to look at the one situation where similar risks have been converted to real losses: i.e. AIG Financial Products (AIG FP).   Chris Whalen of Institutional Risk Analytics has done so in depth in a recent article posted here.

Mr. Whalen paints a picture of financial instruments created for the purpose of enabling financial as well as non-financial companies to falsify their earnings through the issuance of insurance contracts calculated to remove certain assets and liabilities from companies’ books and by doing so to bring them into compliance with regulatory capital requirements or shift earnings and losses between reporting period, with the presumed intent of manipulating the equity prices of the counterparties.  He further asserts that these ostensibly “economic” transactions were converted to blatant fraud through side letters never disclosed to company management, auditors or regulators that absolved the writers of these contracts from responsibility for honoring their commitments.  These activities are further described as the essence of the SEC’s charges against AIG in a Complaint brought against AIG in 2004.

In broad strokes Mr. Whalen then concludes that AIG FP changed its business practices around 2004 to absent itself from issuing insurance products of the type described above.  Instead Mr. … read the rest

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What Does a Bonus Cost?

Posted on February 15, 2009

Consider this fable.

You’ve decided to invest $5 million in backing a champion at the new World Champion Poker Standoff. The rules are simple. Two players will play a winner takes all game of Texas Holdem. Each player will come to the table with a $5 million stake. You might ask why you would consider such an “investment”, but this is not all that different from the game the big banks have played in recent years.

Once in the game, you win a flip of a coin and are given first choice on hiring one of the two champions who will play in the tournament. The only information you are given is the following:

  • Player A wants an upfront cash salary of $400,000 plus a bonus equal to 50% of salary.
  • Player B requires no salary, but demands a bonus equal to 20% of his winnings.

Admittedly you’re missing some fairly important information such as who has the better track record and whether one of the players is a drunk or cocaine addict. But this is a fable after all so you’ve got to play by fable rules.

Given no more information than this, which player should you choose and how much will each player cost you if chosen. I would posit the following:

Player B is the only rational choice. Player A doesn’t have the courage of is convictions. Player B does. While this could be based on a totally unrealistic optimism on Player B’s part, it is more likely based on Player B’s realistic confidence that he will win. Assuming this is the case then the odds favor Player B and the likely cost of each player is as follows:

  • Player A costs $5,400,000 (Salary plus 100% loss of capital)
  • Player B generates a net profit of $4,000,000 ($5,000,000 winnings less $1,000,000
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We Don’t Need a Bad Bank – We Have Several

Posted on January 28, 2009

On Monday the Wall Street Journal published an article containing the chart below showing that some of the major recipients of TARP funds have been wsj-chartshrinking their lending in recent months. What the chart failed to show is why this is the case. The answer is straightforward, but not pretty. Most of the TARP money has been pumped into desperately troubled financial institutions. It should come as no surprise to anyone (other than perhaps politicians) that institutions fighting for survival are unlikely to be focused on taking on new risky investments.

If you look at the same institutions in a little more depth as presented below, it becomes quite obvious that there is a close correlation between the profitability of these institutions and their willingness to lend.

bank-chart-cropped

What’s the profile of a loan officer at a troubled bank?  He or she:

(1) Has been moved into the workout department,

(2) If still in the loan department, is looking furtively to his/her left and right to figure out who’s going to be next to go, or

(3) Has been recently laid off.

Nothing in this scenario would encourage us as prospective borrowers to believe that we’re going to get a loan, nor should it encourage us as taxpayers to expect additional TARP funding to generate new loans from such a bank.

What’s wrong with TARP is that we are putting money behind the losers rather than the winners. We’re filling financial holes created by disastrously bad management decisions in hopes that those who made the bad decisions will make better decisions the next time. The worse the mistakes, the more money the bank gets.

Now is the time for a fresh start – before we spend the next $350 Billion and find that we are just that much deeper in the hole without anything being … read the rest

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